Financing of a farming enterprise is such a critical aspect of overall farm management that it cannot be less than a subdivision of financial management. The distress call from farmers is usually money to keep their enterprises going.
The need usually varies from large amounts of money to finance the purchase of a farm to smaller amounts just to satisfy the need for operational capital. Regardless of what the need might be, the farmer will have to see to it that money he spends will be managed correctly. It is already common knowledge that records are the basis of financial management.
Time and management decisions
The impact of time lies at the heart of financial management. Growth objectives and investment alternatives imply long-term planning horizons for proper economic analysis of all flows of costs, returns and cash resulting from the investment. The results of current decisions may be influenced by costs, returns and cash flows incurred by past decisions. The manager’s inability or reluctance to plan over periods of sufficient length can lead to inadequate economic decisions.
Most of the expectations managers use in making economic choices in the real world are uncertain. Uncertain expectations reduce the reliability of future plans and serve to shorten planning horizons. The need for management arises principally from these uncertain expectations. For some decisions, particularly those of a routine, repetitive nature, the manager can accurately estimate the possible outcomes and their degree of likelihood.
Tools of financial management
The manager needs to develop skills in applying financial management tools. Take note that a computer is not a management tool, but only a facility (device) for the development of managing tools.
Flows of information concerning the past, present and expected performance of a farm business and its operating environment are essential for the financial manager. Internal flows of information are provided by an effective accounting (record) system. The accounting system will generate a continuous flow of information concerning the firm’s liquidity, solvency, efficiency, and profitability. It will aid the manager in controlling his financial affairs, reducing risks, meeting legal requirements, and analysing the farm business, as well as providing a basis for forward planning.
This evidence of financial position also helps to demonstrate credit worthiness and management capability to lenders or other parties upon whom the manager depends for financial support. An effective design of these information flows will contribute to more effective decision making.
Flows of information from the firm’s external environment are provided by literature and personnel of universities, agricultural colleges, extension officers of the Department of Agriculture, mass media, farm organizations, investment services, and agribusinesses. Perceptive use of external information enables the manager to improve his responses to numerous environmental changes. In essence, managers need to anticipate changes and try to be in a position to benefit from them.
The manager needs to develop an orderly budgeting device for gathering information and choosing among financial alternatives. In more traditional farm management terminology, this is called complete or partial farm budgeting. With the emphasis on the firm’s capital resources, cash flows and financial organisation, the process is extended to capital budgeting and to the budgeting of seasonal cash flows.
Capital budgets are designed to enable the manager to efficiently make the best possible investment and financing decisions. More enterprising managers will even find that different levels of technology can be used in forward planning. Many elements of the budgeting process can be incorporated in computerised programming techniques such as linear programming or simulation. The use of a computer can accelerate the budgeting process tremendously, although at a high cost for computer time, especially when making use of the internet.
No planning procedure is perfect! The effective use of the budgeting process does not assure an error-free analysis. The plans derived from either observing the real world, logical deductions, pencil and paper analysis or computer programmes are only as valid as the quality of data used and the manager’s effort in accurately identifying the problem, gathering information, and specifying alternative solutions over an appropriate length of planning horizon. The best judgement of future outcomes still represents expectations on future events which may, in fact, be subject to substantial variation.
A financial manager utilises the knowledge of several disciplines. Traditionally, the study of finance, including agricultural finance, was largely descriptive, emphasising a firm’s acquisition of funds and describing the structure and functions of lending institutions. The pressure for economic growth, however, expanded the study of business finance to include joint analysis of investment, financing and reinvestment decisions and their effects on risks, returns and wealth.
Management of assets, debits and liquidity has become quite important. The general area of farm management, of which financial management is an integral part, has long been considered to be an exercise in applied economics. It is true that much of a member’s behaviour can be explained, or guided, by economic principles. The production economics principles of a firm outline the optimal allocation of limited resources among alternative production uses. The technical disciplines of agriculture – soils, agronomy, animal science, engineering, et cetera – provide information on input-output relationships, new technology and other relevant production information. Principles of exchange in agricultural markets influence the search for and resolution of terms of exchange for resource services, financing, and farm products.
The central principles for economic behaviour in the household are the principles of consumer choice which reflects the allocations of family income among alternative choices in its consumption.
What are the correct principles of financing?
Questions about this aspect are asked daily and every day the sound economic principles are violated. Assets must be financed over a period that coincides with the life expectation of that asset. If financed according to this, it will have a positive effect on the cash flow of the enterprise.
Long term assets like farmland are financed over the longest possible term. Normally the financing period is between ten and thirty years, the longer the better. Short term assets like means of production should be financed over a period of twelve months or less because it will be consumed in the production process.
The question usually arises if you should buy cash or on credit. Because several factors will have to be considered before coming to a decision, a thorough study will have to be done on the farmer’s overall financial position, interest and tax implications, as well as the expected lifetime of the asset. After consideration of all these factors, it may be possible that a cash transaction will be the most expensive.
It is advisable that a comprehensive budget for the next five years should be drafted every year. All income and expenditure should be considered in order to determine the capital requirements for the period as well as the investment possibilities if a surplus of cash is experienced.
Another essential budget is the cash flow budget. This budget concerns the inflow and outflow of cash. Cash loans are indicated in the month received and again in the month of payment. Purchases on credit are indicated only when the account is paid. This budget indicates the exact time when cash moves in or out of the business. It also indicates when surpluses or shortages of cash may occur. This budget will be easily composed according to the production plan for the following year. Another budget that comes in handy is the partial budget. It will be appropriate in determining whether you should buy a petrol or diesel vehicle.
Budgets are relatively complicated, but with the supporting records of previous years, anyone can do it. Budgets and budgeting methods will be discussed in detail at a later stage.
For practical training in the agricultural industry, contact Louis de Jager at +27 82 211 1533.